The Number 1 deciding factor in how much interest you pay to a lender is Mortgage Term Selection. Let me explain why…
Looking for and comparing rates online is easy but what's not so easy is finding mortgage term comparisons. The term of a mortgage is often overlooked by focusing more on mortgage rates. It will truly pay to get the right advice from your mortgage advisor depending on your individual circumstances which term to take but more importantly how much interest and/or penalties you could possibly pay or avoid depending on what mortgage term you take. So to get the term right the first time is very important.
To paraphrase a recent article by Canadian Mortgage Trends; If you pick a closed mortgage with the wrong term you're stuck with that rate until maturity unless you pay a penalty to break it. If you choose a "no frills" mortgage to get the lowest possible rate but with more restrictions you're often barred from breaking that term for any reason except if you sell your property.
Mortgage rates fall into 1 of 2 groups: Long term and short term. Choosing between these terms is not about predicting rates. It’s more about identifying risks and estimating the probabilities of these risks adversely impacting you.
If you are trying to decide which term is best for you, your mortgage advisor should conduct a discovery meeting. They should ask you lots of questions in order to help you make, not only, an honest assessment of your current financial position but also your future plans.
Here are some of the reasons you would want to consider 1 of the 2 groups:
A long-term mortgage makes sense if:
A 25- to 30-per-cent-plus payment increase would cause you financial stress. (That’s the payment hike that a short-term borrower might face if rates rise as economists project.
Your “emergency fund” covers less than six months of living expenses
You have minimal equity and net worth
There’s a chance your earnings could drop due to job instability, a highly variable income, upcoming retirement, an educational leave, an extended care leave, etc.
You’re heavily invested in long-term fixed income, which creates more risk to your “personal balance sheet” if you’ve also got a short mortgage term and rates surge
You want greater certainty when projecting cash flow on an income property
A short-term mortgage may be the way to go if:
You expect to pay off large chunks of your mortgage or sell your home within the next three years
You have a short remaining amortization (e.g. 5-6 years or less)
Your credit is subpar and you need a non-prime mortgage just long enough to rehabilitate your credit so you can qualify with a prime lender
You need to refinance in coming years to access your equity for a life event, education, investment purposes, business use, etc
You strongly believe that rates won’t rise in any meaningful way over the next 12 months, you can afford to be wrong, you’ve found a short-term rate that’s far lower than long-term rates, and you can make higher-than-required payments.
Here's some more in depth examples pulled directly from the article by Canadian Mortgage Trends:
"Let’s suppose you’ve decided a long-term mortgage is right for you. The next question is: Which one?
The answer changes as rates change and at this very minute, it’s almost too close to call. The five-year fixed (currently around 3.24 per cent) and the 10-year fixed (currently 3.89 per cent) are running neck and neck in terms of value.
Assuming you have a 25-year amortization and make payments as if you had a 10-year fixed term, a five-year mortgage will save you $3,259 in the first 60 months, for every $100,000 of mortgage.
By comparison, a 10-year term saves you interest if five-year fixed rates rise more than 1.60 percentage points in five years.
What are the odds of rates climbing 1.60 percentage points? Well, if you believe Bank of Canada warnings and economic forecasts, you shouldn’t bet against it. In the last three interest rate cycles, five-year rates have climbed an average of 2.46 percentage points, albeit for a short time only. So if your financial footing isn’t as stable as you’d like, the 10-year is probably worth the extra “insurance” cost for the peace of mind.
I’ve excluded the comparable math on four- and seven-year mortgages because their pricing simply isn’t good enough at the moment.
If you’ve examined your financial position and found that you’re better suited to a shorter term, the best value currently is a three-year fixed. That is based on the hypothetical assumption that rates will increase moderately starting late this year or early 2013. It also assumes you won’t need to discharge your mortgage early.
You can find three-year mortgages rates today for less than you’d pay with most variable rates and it gives you three years of rate protection.
After three years, you can renew into the best value at the time. You could then choose a variable mortgage, if variable-rate discounts improve – as some people are predicting.
The options laid out above are a glimpse at how a mortgage planner might determine your ideal term. There are, of course, countless other criteria and lots of exceptions."
Tony Marchigiano | Mortgage Specialist - Mortgage Sales BC Region, RBC Royal Bank | Royal Bank of Canada | T. 604-505-7109 | F. 778-737-0054